ASX Takeover: Learning from RejectionPublished: May 10, 2011 in Knowledge@Australian School of Business
When Australian treasurer Wayne Swan canned the Singapore Exchange's planned A$8.4 billion takeover of the Australian securities exchange operator, ASX Ltd, in April saying the deal was not in the national interest, all hell broke loose.
The main reason for the knockback was that a 23.5% stake in the Singapore Exchange (SGX) held by Temasek, Singapore's investment agency, would hand control of ASX to Singapore Inc., potentially undermining Australia's position as a regional financial hub. Australia's regulators gave the deal a collective thumbs down. For the first time in Australia's history, the Foreign Investment Review Board (FIRB) was unanimous in its rejection of a takeover.
Fierce opposition to a deal which would have seen the ASX owned by a foreign government-controlled company was always anticipated.Yet, the criticism was particularly corrosive. Critics howled that the takeover would jeopardise the stability of Australia's financial system since the ASX is the sole operator of the country's clearing and settlement functions. Essentially, the ASX acts as a third party – an intermediary between the buyers and sellers of shares, wearing the risk between the time a trade is executed and the time it is settled.
The opponents of the SGX/ASX takeover – who included the treasurer – claimed the tie-up would not improve Australia's access to Asian financial markets. A merger would result in the ASX becoming subsumed by a smaller regional exchange that is also a competitor, they noted, claiming the move would end Australia's ambitions of becoming a financial centre. Like Australia, the Singaporean government is pushing to export financial services and to become a regional financial hub.
The argument is supported by statistics. The ASX ranks 11th in size in the world with A$1.5 trillion worth of listed companies, whereas the SGX ranks 21st at A$0.672 trillion. Australia is ranked seventh in Asia in terms of liquidity with a turnover rate of about 125% per annum, whereas Singapore ranks 12th with a turnover rate of a much lower 75%. "What chance would ASX have to become a major regional hub if its trading platform was controlled by an exchange that has implemented designs which make it one of the world's most illiquid exchanges?" asks Peter Swan, a professor of finance at the Australian School of Business.
Professor Swan is sympathetic to government blocking the SGX/ASX deal on nationalistic grounds, but not because of the foreign control issue. The takeover would have jeopardised the listing and trading of Australian listed companies, he says. Australia's solid reputation for good corporate governance and a sound legal system would be irrevocably hurt by an SGX takeover of the ASX. "Australia does not want to weaken its position in Asia by being swallowed up by a competitor which is less efficient, smaller and has a poor standard of corporate governance and controls," Professor Swan says. "There is little evidence of the `rule of law' in Singapore, which has embraced a form of crony/state capitalism."
Professor Swan also sees the likely poor management of the ASX by Singapore as a key deterrent. "The SGX is a poor-performing exchange with poor liquidity and capitalisation," he says. "Australian regulators opposed the deal because the SGX is one of the worst regulated and run and most inefficient exchanges in the world. The ASX is imperfect in many ways, but far better run than SGX." While the Singapore Exchange and ASX have long been able to trade on each other's exchanges, demand for that service was weak, Swan observes.
Supporters of the deal were equally vociferous. They called the national interest argument specious, full of bogus reasoning. A successful takeover would have created Asia's second-largest exchange by number of listings, behind the Bombay Stock Exchange but ahead of exchanges in Tokyo and Hong Kong, they argued. A major concern was the ASX missing out on the benefit of a wave of exchange consolidation around the world to build scale and cut costs as competition increases from "dark pools".
Tokyo and Osaka exchanges are in talks; Deutsche Boerse is going head-to-head in a partnership with Nasdaq OMX Group and IntercontinentalExchange to takeover the New York Stock Exchange/Euronext; and London Stock Exchange wants an alliance with Canada's TMX Group, operator of the Toronto and Montreal bourses. Notably, similar national interest issues have been raised in Deutsche Boerse's bid for NYSE/Euronext as well as for the LSE/TMX marriage.
The consolidation advocates called the FIRB "inconsistent and bizarre" for nixing the Singapore-Australian exchange transaction when the domestic equities market was about to face intense competition from Japanese exchange group Chi-X. The ASX will face share trading competition for the first time after the federal government granted Chi-X a full securities exchange licence on May 4. Chi-X's Australian-based operations are expected to begin in October.
Supporters of the takeover also disagreed with the treasurer's "clearing house" issues, blaming Wayne Swan for not taking action to split out the ASX's clearing and settlement systems while the Singapore bid was on the table. They claimed the SGX/ASX deal fell prey to politics and that its rejection threatened Australia's reputation as a country that welcomed foreign investment.There was a lack of political support in Canberra for revoking a law that prevents a single shareholder from owning more than 15% of the ASX. A minority-led government, reliant on independents and Green party parliamentarians, was unlikely to pass the legislation required for the deal to go ahead because the government cannot afford to alienate the cross-benchers.
Rejection of the ASX/SGX merger may have the consequence of reducing Australia's role in the international capital markets, asserts Robert Milbourne, the mining and resources partner at law firm Norton Rose. And, the upshot may be negative consequences for Australia's market-leading role in the mining and resources sector globally. With the expansion of capital demands for major mine projects internationally, capital raising will require increasingly deep markets, Milbourne points out. Corporations will continue to migrate to the larger exchanges and, simultaneously, seek to comply with a more limited number of listing exchange requirements, he predicts. "Should the LSE/TSX merger succeed – each with already well-established mining and resources firms listed – there may be a significantly increased pressure for ASX-listed firms to consider alternatives in the international markets, which they may not have done if the ASX/SGX merger was permitted."
However, Professor Peter Swan totally rejects the idea that Australia will be left out in the cold as the world's exchanges move to amalgamate. The treasurer's knockback will have quite the opposite result, he believes, noting that the treasurer did not rule out a successful bidder if the ASX found a deal that was right for Australia – one that fostered links with global capital markets and exchange networks and boosted access to capital for local businesses.
Faced with a rival, ASX management clearly wants to sell and, with its dominance by the resources sector, it's attractive to exchanges round the world. There is no reason why the ASX will not find a more natural partner – like the LSE/TMX consortium – to bring together the world's largest natural resources and mining listings. Takeovers succeed or fail based on the value offered to target shareholders. Synergistic benefits would come from being part of an exchange housing most of the world's mining companies. Ultimately, what counts for successful acquisitions are the management skills of the acquirer and the end result – that the total is worth more than the sum of the parts.
In addition, Peter Swan suggests that the ASX might resume its earlier merger talks with the Hong Kong Exchange, which in turn is likely to merge with the Chinese exchanges. Hong Kong has a liquidity rate of about 90% and market capitalisation twice that of Singapore. "To improve our reputation, so we can raise more capital and run a more efficient market, the LSE or Hong Kong exchanges would be the best way to go," he says.
To Michael Aitken, chair of Capital Market Technologies at the University of New South Wales and chief scientist of the Capital Markets Cooperative Research Centre, the issue is all about efficiency and integrity rather than any nationalistic instinct or warding off predators. Local arguments for and against the ASX-SGX merger are little more than "unsubstantiated assertions mixed with the usual array of `redneck' rankle dressed up in the cloak of national interest", insists Aitken. There has to be a more objective way of deciding whether a proposed merger is good or bad for Australia, rather than relying on the vagaries of political process, he says.
Decisions must be assessed in terms of how the proposed changes will affect the efficiency and integrity of the market, the universally acknowledged mandate of securities regulators, including corporate regulator, the Australian Securities and Investments Commission (ASIC).
ASIC has a mandate to ensure that whenever a market design change is contemplated – such as the Australian-Singapore merger or the introduction of Chi-X – that it passes the dual tests of market efficiency and market fairness. This is the central function of securities markets, Aitken points out, and that is what the government and its advisors should be trying to assess. "If the proposed changes do enhance fairness and efficiency, the regulators are obliged to accept them," he says.
Aitken is calling for a more evidence-based policy framework when evaluating market design changes. Without this, the outcome of the merger may well be decided by political clout, rather than whether the transaction will enhance the quality of securities markets. "We need an objective basis for making these decisions," Aitken says. "The [Foreign Investment Review Board] didn't say why it blocked the merger; there was not enough explanation of why this deal didn't go through and there was no proof that the FIRB reached its decision logically." So how do we practically measure whether the Australian market is better off alone or in combination with Singapore Exchange?
Where's the Evidence?
Objective evidence for the decision was also not provided by the corporate regulator, Aitken asserts. Australia needs a clear definition of market efficiency and integrity. The clearer the definition, the more obvious will be the elements that need to be measured and assessed. "If we define an efficient market as one in which it is cheap to trade, and in which an investor can be sure that the price that they are trading reflects all available information, then we need to seek evidence that Aussie investors – following a market design change – will face lower transaction costs and reduced time for information to be impounded in the price," Aitken says.
What needs to be clearly outlined and demonstrated is how innovations in market design (such as making market data freely or more cheaply available or reduced transaction costs) as a result of a merger would speed up the time it takes for information to be impounded in the price. Market efficiency metrics should be used to clearly show the cost of transactions and price discovery before and after a merger.
Metrics on market integrity also exist and include the extent of insider trading, market manipulation and broker-client conflict (front-running). ASIC needs to establish a framework outlining the metrics by which the parties will be judged to make clear the impact of proposed market design changes on efficiency and integrity, Aitken emphasises. "Singapore may not be the right partner for the ASX, but that is not the point," he says. "ASIC should be telling Singapore to prove that a takeover will make our market more fair and efficient." The corporate regulator should have told Singapore exactly what evidence was needed, he says.
Evidence of how such changes have affected other markets would be useful, Aitken says. Where the market structure changes have not been tried elsewhere, senior management at the ASX and the SGX should have been made to show that the proposed change would have the desired effect. If things had not gone well, they would have had to tell ASIC what they would try next to achieve the desired results and face regulatory penalties for failure to deliver as public entities do when they get it wrong.
"While regulators around the world spruik a common efficiency/fairness mandate, they don't tell us how one might go about providing objective evidence to meet these conditions," notes Aitken. "Therefore, it's little wonder that decisions on optimal market design are short on facts and long on rhetoric. As long as this situation remains, decisions will take an age to make and, ultimately, will be based on who can shout the loudest."
The `clearing function' objection is a complete furphy, Aitken asserts. "The question still becomes: Does a market which has both the clearing and trading functions in one entity lead to a market that's less fair and efficient?"
It's time for more than lip service to be paid to evidence-based policymaking, he says, because this won't be the last market structure change suggested in Australia.